Why Small Caps Could Become King
The government fundamentally shapes business and every facet of our economy. Who’s in charge at the executive level and in the House and Senate weighs immensely not just on the US economy but especially on the stock market as well.
And today I want to address one of the greatest lies of politics: That the Republican Party is the party of the ultra-wealthy.
Now, I don’t care if you are on the left, right or simply don’t care… But this is an important thing to understand for the markets. This idea is fundamentally wrong — and in reality, most ultra-wealthy folks have been strong advocates of Democrats.
But why?
Well, the answer is simple: A more regulated, higher tax environment (like we see more commonly in Democrat legislation) benefits the elite.
It makes it much harder for smaller companies to get market share, navigate shifting regulatory environments, get access to capital, and compete with large companies where the elites have much of their wealth parked.
The elites don’t want small innovative companies eroding away at the market share of giants.
Just take this chart as a perfect example of this principle:
In purple, we see the QQQ, which tracks the performance of the 100 largest non-financial companies listed on the Nasdaq. These are companies like Apple, Amazon, Google, Meta, Microsoft, etc.
In orange, we see the S&P SmallCap 600 Index, which roughly covers the small-cap range of American stocks. And in blue, we have the Russell 2000 index, which is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell Index.
And take a look at how these have all performed over the last 4 years. The big names that the elites control are up 132% (remember, these are the companies traditionally thought of as friendly to Republicans because they are the ultra wealthy). Meanwhile, the small-cap indices are up only 37% and 31% respectively.
Left leaning legislation makes it hard for these small companies to compete with the megacaps of the world.
So, what would it take for a small cap to compete with a large or mega-cap company like Amazon?
Let’s say they wanted to compete with Amazon’s cloud computing (AWS) offerings…
They’d need data centers, which require access to large sums of capital, which is hard to get in a high interest rate and inflationary environment. They’d need to navigate a plethora of privacy laws, regulations, and the FTC just to get up and rolling.
A small startup doesn’t have hundreds of employees to assign to all the tasks needed to compete in a high regulatory environment so they’re locked out of the market and the juggernauts of the world scoop up their market share.
A Futile Effort
In my opinion, it’s painfully clear that the government has a lot to do with the largest companies on earth continuing to dominate. Why? Because the government excels at creating rules.
It’s as if they sit around all day, brainstorming new regulations (oh wait, they do). Of those rules, thousands of pieces of legislation are aimed at businesses. And businesses are forced to comply with these new rules and regulations on a constant basis.
Now here’s the thing, most of our politicians aren’t successful business professionals. I know this might shock you, but they often pass regulations without really understanding how they are going to impact the businesses they’re attempting to govern.
Ultimately, a very high percentage of legislation is harmful to the businesses they’re imposed on.
So think about it like this: Which companies are best equipped to handle harmful regulations?
It’s undoubtedly the largest and most profitable companies on earth. In fact, crippling regulation is often a concealed advantage for businesses that can withstand it. It strains smaller competitors from the market.
We see it play out something like this:
In the age of Amazon Prime and all things delivered to your door, the government is hearing reports that delivery trucks are increasing their carbon footprint at an untenable rate.
Clearly, the federal government must step in to reduce excess carbon. So, they pass legislation requiring any company with 3 or more delivery trucks to install reporting devices on their vehicles to track carbon output, upgrade their catalytic converters, and restrict the same truck from following the same route multiple times a day.
They pat themselves on the back for a job well done and move on to the next set of rules they want to impose.
Meanwhile, Andrew and Son’s Produce Delivery, Little Town Hauling, Johnny’s Goods on Wheels, and a thousand other companies like them wrestle with the new regulations.
These small companies don’t have the staff to manage the new requirements. They don’t have the extra revenue to make updates to their trucks. And they certainly don’t have enough scale to limit their trucks from doing multiple deliveries on the same routes.
In other words, this regulation is a back-breaker for small to medium-sized delivery companies.
At the same time, Amazon — which you could argue the bill was essentially aimed at in the first place — has very little issue complying with the regulation.
Sure, they’ll lose a few million dollars along the way, but compared to the market share they will inevitably pick up from the myriad of other businesses going under, that’s nothing.
They have enough trucks taking enough routes that a quick revamp of their AI-driven route planning system will solve that problem.
They can order 10,000 catalytic converters at a bulk discount and have their in-house mechanics install them along with the required reporting tech.
The new law is a frustrating line item on one quarterly report, but barely a blip on the radar for a company like Amazon. Yet it could be a death sentence for a small family business.
At the end of the day, the regulation was a hidden advantage for a company like Amazon. And, frankly, the more strenuous the regulation, the more advantageous (long term) for the companies that can handle them.
This is why I believe left-leaning policies and a big government are a critical advantage for big business.
So why do I think small caps could be getting their chance?
As I showed you in the chart above, for the longest time we’ve seen small caps lagging behind large caps at a historical rate.
But the world may look very different very soon. Interest rates will likely start coming down, and inflation has tamed somewhat despite the higher price environment we are all now living in.
With lower interest rates, smaller companies can get access to capital, investment, and loans much easier. That means growth for these small-cap companies.
Just look at how much better these small companies performed in a Republican (Trump) presidency than during a Democrat (Biden’s) from the earlier chart:
Obviously, as I have been illustrating, big business will likely always grow and surpass small companies. But small caps flourished exponentially more under a Trump presidency than they have under a Biden presidency… Just compare the charts.
And as I shared yesterday, the events this past weekend made the election feel like it was over before it had even had a chance to begin. I think this has already started to be priced in with the run on small caps we’ve had this week.
So, if we consider that in the short term, a Trump victory is being priced into the stock market, we could see some growth in small caps in the near future right as the Fed likely begins to lower interest rates in September.
Then if we do actually see a Trump win, we could be looking at a four-year runway for small caps to not only catch up to large caps but begin to dominate in returns for our portfolios.
Remember — historically, small caps produce larger net gains than large caps and, right now, they are lagging far behind. So there is a ton of room for them to catch up and it could be a moonshot opportunity if things play out the way they look right now.
By the way, I am watching some of these smaller caps with big room to run in my Jump Trades service which targets triple digit returns.
I just opened up more spots in Jump Trades because I am so excited about what we have in front of us right now… Including a new trade this week targeting around 200%.
Watch the special presentation here.
—Nate Tucci
